How Much Are Differences in Managerial Ability Worth?

Abstract:     
This paper attempts to measure how much differences in managerial ability can affect firms' values. If transaction costs or firm specific human capital prevent the firm and CEO from recontracting to the CEO's market wage, then the value of the firm will depend on the continued employment of the CEO. Assuming perfect capital markets, abnormal returns surrounding the sudden termination of the manager/firm relationship will reflect these quasi rents. Applying Lazear's (1986) model of raids in the managerial labor market, we argue that only high ability executives are bid away by other firms. By comparing the abnormal returns associated with loss of an executive to another firm with those associated with loss of an executive by sudden death, we attempt to derive a measure of the relative contributions to the value of the firm (net of wages) of high vs. average ability managers. We find positive abnormal returns in response to sudden executive death and negative abnormal returns in response to top executives being bid away by another firm. In addition, we find a negative event response when an executive is bid away by a larger firm and a positive event response when managers leave for smaller firms. This finding is consistent with Rosen's (1982) hypothesis of a complementarity between firm size and managerial ability.

Note: This is a description of the paper, and not the actual abstract.

JEL Classification: G30, J31, J41

Accepted Paper Series